Deleveraging causes short-term pain but long-term gain

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CLARKONOMICS: We are in the midst of a difficult time, but I want to say this to you: Don’t overreact.

We as a country have messed up over a while. There was too much credit available and you had multiple bubbles in technology and real estate, to name a few. We had a “let the good times roll” mentality and did a lot with borrowed money that in hindsight we know was not a good idea.

It became way too easy for someone to buy whatever they wanted without having to prove income just by getting 100% financing.

You know the consequence of that trend in the housing market: A run-up in value followed by the bust. In the tech sector, you had the NASDAQ topping out over 5,000 at the peak of the “dot com” bubble. Today, it sits at 2,378 all this time later. Values are still less than half of the peak, but the peak was a false peak and in fact a bubble.

Then you look at what happened at the individual household level. We as Americans took on crazy levels of debt, spending $1.36 for every dollar we made when we hit the wall four years ago. Yet today, we are in the process of what’s called deleveraging.

Deleveraging means resetting our personal balance sheets by reducing our debt and reducing spending. We’re going from what economists call “negative net saving” (meaning we spend more than a dollar for every dollar we earn) to net savings of about a nickel out of every dollar we make today.

Of course, a nickel is not enough savings to provide a comfortable retirement, but it is helping reverse the process and move in the right direction.

Today, we’re at about $1.12 of spending for every dollar that comes in. That will keep going down as we save more money. Deleveraging means no more “shop ’til you drop.”  It also means looking at the wheels in the driveway and keeping those cars. Sure enough, the latest auto sales show that’s exactly what’s happening.

The growing reluctance on our part to be spending fools sets our economy up for long-term health but short-term pain. In the past, we were living an unrealistic life in an unrealistic economy. The same goes for the promises government made. That’s why government is now retrenching at all levels. We are at a crossroads about the future size and role of the federal government. The feds have gone from trying to provide booster shots over the past four years to being part of the deleveraging.

The thing is this: We will have to deal with a bumpy road for what could be years to come. That is not necessarily a bad thing. (Of course, it is a horrible thing if you are unemployed. There’s an old expression that says “it’s a recession if you have a job and a depression if you don’t.” That is certainly the reality as people have faced difficulty in the job market.)

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People are craving certainty in an uncertain time. The tendency at this time is to look for whatever the safe zone may be. A lot of times we will overreact in these kinds of circumstances. What I’m doing today and will continue to do day by day is take questions from you to get your perspective.  Then in turn, I hope to provide info that hopefully offers guidance to others about how to proceed in these uncertain times.



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